FX Strategy going forward

NFPs were stronger-than-expected, but by no means fantastic at 175k, just below the mean (188k) for the last year. The ECB came out, not concerned about EUR strength, and while not hawkish, just less dovish. With the STIR future still implying a yield of less than 0.5% out to December 2015, there is not really a chance for the rate path to be pushed out in time.

(This being said, the BIS had a nice chart in the quarterly survey suggesting rate paths as per Central bank projections are pretty rubbish, and if they can't get it right... who knows?)

Black - Actual, dotted lines = expected.

Going forward: looking at EUR forward swaps, there is honestly little room lower. the 3 month rate 1 year forward is at a mere 0.34%, and the USD equivalent at merely 0.44%. I see the short end of the yield curve being the main driver in G10 FX (ex JPY and AUD vis a vis the USD) for the foreseeable future, and as such, short end forwards give me a good guide as to current yield differentials and where they see monetary policy going in the next 12 months. Even though Eurodollars see hikes >1y away, there is still a clear and present divergence between monetary policy. This being said, in the shorter term as can be here, the possibility for a month through 1.40 and to 1.42 is quite likely. Longer term though, I see a reversion to historical relationships that we've seen (such as 2Y sov spread).

For now though, the EURUSD will be most sensitive to the very short end (3M OIS spreads etc) and as such I don't expect any serious downside for a longer period of time. >6M away.

1y forward 3 month swaps top pane, spread in red, EURUSD in green

As such, when the time comes that US data, and importantly data surprises start to pick up, I expect to see the EURUSD trade more akin to the spread (as seen above), but that is a while off, with meh NFPs and the .CESIUSD dropping like a stone (because the weather... right?)

CitiFX economic surprise index for the USA

Overall, still bearish USTs and happy to add shorts on the belly of the curve, but cautious on USD - there won't be any strength unless we see a significant pick up, its not like the ECB can do anything to weaken the EUR (if they even want too!), even a rate cut wouldn't do much. I think it would require QE...

RBNZ and the NZD: It is no secret the RBNZ don't like the height of the NZD. its the strongest currency YTD (+2.95 vis a vis the USD). Trading at 0.85, its definitely elavated, and importantly the current implied yield on a 1Y forward is about 3.21%, far above the 2.5% or so base rate spread. So basically the swaps market sees hikes, and plenty of them... in fact by my crappy calculation and composite chart I made I get about 123bps worth of hikes in the next 12 months.

Red (filled) RBNZ exp., RBA in white, Blue is spread, AUDNZD in red

 As we can, 123bps is priced in, and we can only assume that is in the NZD FX rate too... Where as the RBA expects about 1 hike in next 12 months, with rates expected 40bps higher next year.

All in all, I think there will be less than 125 bps of hikes in NZ and more than 40bps of hikes in Aus. So, one can only deduce in terms of FX exposure, being Long AUDNZD (and short NZDUSD in due time). Reason for the lack of hikes comes from my friends blog Here and many others, notably FX rate impact, "slowing" in some impactful EM, and Australia not much worse than NZ at all.

But broadly, I've made a point of downside vol in AUDNZD being too expensive given the pricing of rate hikes in the market, and I still firmly believe this however since posting it here, the risk reversal skew has come off a lot, with the 3M smile looking almost symmetrical.

GBP and why I see limited upside: I've summarized these points, multiple times recently on twitter, but here are my thoughts in one place.

1.) Forward rates, and spot rates have reached a ceiling, GBP 1y1y at 1.3%, GBP 1Y forward implied yield at 0.34%.

GBP vs 1Y implied yield, 1y1y on bottom

2.) Growing CA deficit - quite simple, likely to weigh on GBP over time, therefore medium term, I can't get too constructive GBPUSD

One worrying thing long term for GBP is the CA deficit. Just look at our neighbours on this... pic.twitter.com/7275fcAoJL
— Jere Wilkinson-Smith (@JeremyWS) January 21, 2014

'Nuff said on CA

3.) Positioning in the market - As per BNP Ps FX positioning indicator GBP is most longed. At threat of weak longs capitulating at the first sign of dovishness from BoE, or loss of momentum in UK macro. On the latter, PMIs very strong, hard to sustain that level, likely drift lower into 55's and could weigh.

BNP Paribas FX positioning - still heafty GBP longs, CHF flipped from short to long, growing CAD shorts too. pic.twitter.com/54zYHUFiNH
— Jere Wilkinson-Smith (@JeremyWS) February 27, 2014

I usually look at risk reversal as my positioning indicator, in fact my GBP fair value model is simply Risk reversals and interest rates, It has worked *very* well.

On top of this, IV has been very suppressed, and in fact the market seems short Vol, leading to an overall short gamma position. Thus if the newsflow is quiet, the hedging could dominate short term flow and a move lower will be pinned down by sellers of small rallies. Obviously the vice versa is true, with rallies being supported by dips buyers well.

4.) Techs, see previous post here - timing not fantastic, but added shorts and so avg, is 1.67 or so. More rationale behind GBP short there.


Either way - these are my thoughts going forward, hope you enjoyed. Thanks.

(originally planned on some EM, but getting late and school in the morning)